The economies across the world are showing recovery driven by profits. However, one cannot neglect the implication of such recovery for the long term growth given the pressure such recovery has been exerting on the labour markets. The article deals with this issue.

3 Ways to look at GDP

• The first is what they tell us about the past.
• Here, the news has generally been better-than-expected.
• The US and India saw a much stronger recovery last quarter than previously envisioned.
• The second is sectoral, production side-agriculture, manufacturing, services- and the functional, expenditure side consumption, investment, net exports.
• But there’s a third way — the income side.
• Value addition must ultimately accrue to the different factors of production.
• On the income side, therefore, GDP is simply the sum of profits, wages and indirect taxes.

Profit-driven growth and impact on employment

• The economic recovery in many parts of the world is driven disproportionately by capital than labour.
• In India, the net profits of listed companies grew 25 per cent (in real terms) last quarter. This despite revenues shrinking.
• Revenue shrank because firms aggressively cut costs, including employee compensation.
• This implies that if listed company profits are growing 25 per cent, and yet GDP contracted 7.5 per cent, it reveals (by construction) significant pressure on profits of unlisted SMEs, wages and employment.
• Labour market pressures are evident in India too.
• Household demand for MGNREGA remains very elevated, suggesting significant labour market slack.
• The employment rate in some labour market surveys still reveal about 14 million fewer employed compared to February, and nominal wage growth across a universe of 4,000 listed firms has slowed from about 10 per cent to 3 per cent over the last six quarters.

Why this matters

• It may be rational for any one firm to boost profits by cutting employee compensation.
• But if every firm pursued that strategy, that simply reduces future aggregate demand and profitability for all firms.
• This is quintessential fallacy of composition that Keynes enumerated.
• Weak demand, in turn, disincentivises re-hiring, reinforcing the risks of settling into a sub-optimal equilibrium.

Need to remain vigilant about labour market

• Remaining vigilant about labour markets is particularly important for India.
• Private consumption was increasingly financed by households running down savings and taking on debt pre-COVID-19.
• Consequently, if job-market pressures induce households into perceiving this shock as a quasi-permanent hit on incomes, households will be incentivised to save, not spend in the future.

Way forward for fiscal consolidation

• While economic momentum is expected to slow as pent-up demand wears off, the level of output will progressively reach pre-COVID levels as the economy normalises.
• The question is what will drive growth after that?
• India’s fiscal response has been restrained thus far, with the Centre’s total spending similar to last year and state capex under pressure.
• It’s therefore important for the Centre to step up spending in the remaining months.
• More importantly, public investment, and a large infrastructure push, must be the leitmotif of the next budget.
• This will be crucial to boost demand, create jobs, crowd-in private investment and improve the economy’s external competitiveness.
• If higher infrastructure spending is financed by higher asset sales, the headline fiscal deficit (which matters for bond markets and interest rates) can be slowly reduced, even as the underlying fiscal impulse (which matters for growth and jobs) remains positive.
• This is the only way to undertake fiscal consolidation without incurring a fiscal drag.
• Monetary policy has led the charge in 2020. But with inflation continuing to remain sticky and elevated, the RBI has fewer degrees of freedom going forward.

Conclusion

The stronger-than-expected GDP print is very encouraging. But this is the start of a long journey back. Much, therefore, remains to be done. The excitement around the vaccine shouldn’t obscure this fundamental premise.

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